Real World Economics: Railroad regulation a question of benefit

A friend was livid when he heard that farmers in the Dakotas and Montana are calling for federal action to force railroads to move grain faster, despite burgeoning oil shipments.

"Farmers are the biggest hypocrites," he said. "They decry wasteful spending but throw fits at any threat of cuts in farm payments. They criticize government regulation, but when market forces hurt them, they go bawling to the federal government demanding intervention!"

Is his criticism correct?

On the question of subsidies he is certainly right, although farmers are hardly unique. Members of every group nursing at the federal udder deeply believe in the economic necessity and moral justice of their particular government benefit -- be it hedge fund managers who benefit from the "carried interest" tax avoidance scam or the oil companies (and small Minnesota gravel sellers like me) using "percentage depletion" or well-off retirees whose prescriptions are paid for by working people.

However, on the rail service question, the answer is maybe. Rhetoric of being against "excessive regulation" generally gives politicians -- and farmers -- a convenient out. But if you want regulation to benefit you, it's easy to claim that it isn't "excessive."

This strikes at the classic definition of economics, which is deciding how to allocate scarce resources. And the standard economists' prescription is to let market forces respond before letting the government step in.

Some 125 years ago, society decided that railroads, by charging excessive rates, abused their monopoly status in many communities or industries. So we passed the Interstate Commerce Act of 1887 that regulated such rates.

Economic theory of monopoly profit-maximizing was not advanced at the time, but it eventually demonstrated that unregulated monopoly pricing also hurt economic efficiency and thus wasted resources. Government regulation could restore some of this lost efficiency, although this depended on how effectively it was carried out.

By the time 90 years passed, it was becoming evident that the economic inefficiencies induced by rate regulation outweighed society's gains from the reduction of monopoly pricing power. And innovations, especially the interstate highway system and the long-haul semitrailer, had on their own sharply reduced the monopoly power of railroads for many shipments and in most geographic areas.

So the response was to deregulate rates for transportation generally. This was a major policy thrust of the Carter administration, although the seeds were laid in 1971, during Nixon's term.

The move is widely seen as a great success. A once-stagnant rail industry has boosted investment in tracks and rolling stock. Many rates, adjusted for inflation, have fallen. Tonnage moved has burgeoned. While the Association of American Railroads is not an unbiased source, its claims that rates have fallen by about 50 percent and that a half-trillion dollars of new investment has been made are generally thought to be in the ballpark.

The U.S. certainly has the most efficient freight railroad system in the world and it is a source of enormous comparative advantage relative to other nations. Moving soybeans from farms to export ports in the U.S. is a fraction of what it costs in Brazil, for example.

Not all rail industry improvements stem from deregulation. Related cost reductions took place at the same time as increased innovation, including enormous increase in the capacity of shipping containers on trains.

Moreover, government oversight has not been reduced to zero. A new Surface Transportation Board that replaced the old rate-setting Interstate Commerce Commission still has some powers. One is to limit new contracts, such as for hauling oil, that harm the ability of railroads to provide "common carrier service" for existing customers such as grain elevators.

A large majority of grain hopper cars is owned by elevators or other grain companies themselves. The railroads provide the locomotives and track infrastructure. Railroads still are required to haul grain trains for shippers, which often are farmer-owned cooperatives. As long as the railroads had plenty of capacity, they were happy to haul grain. But now they also face demands for service from crude oil shippers. So the grain suppliers have to wait.

Railroads, especially the BNSF and Canadian Pacific, which are the most affected by the oil boom, are responding to increased demand. They already are buying new locomotives and making improvements, such as new long sidings, that facilitate running more trains over existing track. Longer-term improvements are in the works, although any business would be hesitant to make investments that can only be recouped over decades if those investments might be rendered unneeded by some outside action such as new pipelines.

Market forces will force other adjustments. More oil flows east than west. So moving grain west to the Columbia River or to Portland, Ore., will gain and shipments to Duluth may fall. Trucks will be competitive over longer distances. Rather than going east or west, more grain will flow south to the Union Pacific lines across Nebraska and Wyoming, which handle less oil traffic. Ditto for the former DM&E line, now CP, from western South Dakota to the Mississippi. Mayo Clinic surgeons better get used to the idea that more grain trains will rumble through Rochester.

Moreover, grain shippers clearly will get service if they are willing to pay more than the oil shippers. That is the classic market outcome. The buyer for whom the service has the greatest value will end up getting it if they are willing to pay for it.

In the short run, "basis" or price differences between rural elevators and those at destinations like Chicago, Duluth, New Orleans or Portland, will be increased by all of the above market responses. That means lower prices for farmers. And that is politically unpopular.

So anti-regulation Republicans in Congress are tut-tutting just as loudly as Democrats about the unfairness of the farmers' plight. While the Surface Transportation Board has rarely acted in response to common carrier-access complaints, this is a case where it may. Just how it will respond is anyone's guess. And whether the outcome is good for society as a whole is something economists will hash over for years.